Mongolia is a country with natural resource wealth that holds sizable per capita GDP possibilities for a national population of roughly 3 million people. Since the discovery of the world class Oyu Tolgoi copper-gold mine in 2001, Mongolia has had a back and forth struggle between populist national interests and welcoming laissez-faire policies dating back to the passage of a 68% windfall profit tax passed in 2005 and its annulment in 2009. The back and forth continues this year with moves forward towards truly opening up the Mongolian Stock Exchange (MSE) to foreign ETFs, mutual funds and institutions for the first time.
Saruul Ganbaatar, outgoing Deputy CEO of the MSE after three years on the job, was interviewed on Skype to provide a sense for where the legal changes are taking Mongolia and why investors should believe there is no going backward after the government of Mongolia’s recent legal changes.
Jon Springer: You went on road shows around the world promoting the MSE recently. What was your message at the road shows?
Saruul Ganbaatar: Our key message entailed that Mongolia is going in the right direction. Mongolia abolished some of the controversial laws such as the Strategic Entities Foreign Investment Law (SEFIL) and the old Foreign Investment Law. The parliament replaced them with one law that governs the investment environment in Mongolia, the new Investment Law. At the same time, this past year we put through a new rendition of the Securities Market Law and a new Investment Fund Law.
These are some of the sizable developments towards attracting capital to Mongolia. The Investment Law took effect on November 1, 2013. The Securities Market Law and Investment Fund Law took effect on January 1, 2014. So, we met with institutional investors from Hong Kong to New York to let investors recognize that Mongolia is open for business and that the country is looking to continually build a sustainable environment for investments. The new investment law has laid out some specific tax incentives and non-tax incentives for investments. There is also a specific clause in the law that outlines protective measures of the investors’ interests in Mongolia. The new securities law also brings in more transparency for Mongolian companies and their reporting requirements.
For the exchange, we will have a new clearing, settlement and custody environment. For 22 years since the formation of the MSE, the market was prefunded. With the new law, we are moving to the T+3 standard, which is adopted around the globe and is a crucial arrangement that will allow sophisticated institutional investors and mutual funds from overseas to begin investing in Mongolian listed companies.
Springer: Foreigners could invest on the MSE before. Do these laws fundamentally change the market in any way?
Ganbaatar: In most countries, it’s a common practice that, whenever institutional investment funds channel funds into the countries’ securities markets, they hold both securities and monetary assets in sophisticated A-rated custodian banks. The adoption of a newly amended law introduces a much-needed legal framework for the creation and operation of local and sub-custodian banks. We now have the necessary clauses in the Securities Market Law, and necessary regulations, which have been drafted over the last 4 ½ months, to go ahead with custodian relationships that create the necessary infrastructure to attract institutional money to Mongolia.
We are also bringing in the legal concepts of nominee and beneficial ownership that haven’t existed here before, which sets out the groundwork for funds and most global custodian banks to start forming partnerships in the Mongolian marketplace. The Investment Fund Law was also drafted in-line with the Securities Exchange Act and the Investment Company Act in the United States. It puts in place strict standards and regulations for managing public funds and provides a description of the range of securities investments that mutual funds, ETFs, closed-end funds and private investment vehicles are allowed to invest in.
Springer: Did the Financial Regulatory Commission (FRC) change laws this year as well?
Ganbaatar: The FRC together with the MSE has redrafted 22 regulations in line with the new Securities Market Law. An interesting thing to note is that the new listing rules of the MSE and the FRC will require that financial statements be filed in both English and Mongolian, which will help provide investor confidence.
Springer: Do the new regulations make dual-listings on the MSE and international stock exchanges possible?
Ganbaatar: Yes, we are bringing new tradable securities to our markets that are common elsewhere: options, futures, depository receipts (DRs) and warrants. The introduction of DRs is an interesting new addition. It will provide local issuers with opportunities to float on foreign exchanges and execute those transactions in either shares or depositary receipts. DRs appear to be attractive addition for local Mongolian companies listed in overseas markets, for the newly amended regulations will open up opportunities of having straight access to our domestic pool of investors.
Springer: The Foreign Investment Law of 2012 (known as SEFIL) was a rushed law in the run-up to 2012's summer elections. How is this law different?
Ganbaatar: The Investment Law is making bold steps to attract capital to Mongolia. This law makes no distinction between foreign investors and domestic investors. The old SEFIL had some limitations for foreigners with regard to investing in mining, finance, banking and telecommunications sectors. The only restrictions remaining now are in connection to state-owned entities.
Springer: SEFIL’s passage happened as a populist reaction against a Chinese company taking over a sizable coal mine in Mongolia. What ensures foreign investors against another political issue changing the law?
Ganbaatar: To provide a further level of comfort, the law stipulates that the government provides a Stabilization Certificate to the investor and stabilizes the terms of investments anywhere from 5 to 20 years. The rates of corporate income tax, VAT, royalty and custom taxes will be fixed during the duration of the stabilization term. The length of the stabilization period will be linked to the amount of the investment by the investor. This arrangement would allow investors to make sizable investments into the country with a long-term view. The Stability Certificate will be issued by the Ministry of Economic Development. For any investments exceeding 500 billion MNT (roughly 300 million USD), the government of Mongolia will sign an additional Direct Investment Agreement further guaranteeing all the incentives described in the law.
The law stipulates that it will require two thirds of parliament to amend or abolish it, which makes me believe that this law will be in place for quite some time.
Springer: When I visited the MSE in September 2011, trading was done on the floor with slips of paper. Is that still the process?
Ganbaatar: Technologically, we have integrated Millennium IT which is used by 30 different financial organizations across the world including London Stock Exchange Group, London Metals Exchange and Johannesburg Stock Exchange. It is a highly sophisticated trading and post-trading technology that has the capacity to handle high trading volumes and a variety of securities classes. Starting in April 2013, half the brokerage firms trading on the MSE began trading from their offices remotely. Most of the industry is moving towards Internet trading, and we are moving in that direction as well.
We have also started cooperating with FTSE to design indices. Separately, we have been placed on FTSE frontier market watch list. If we are added to FTSE frontier market index FTSE frontier market index we will be tracked by some of the largest institutions investing in frontier markets, which, in our view, will provide additional liquidity to our markets.
Springer: In the past some companies only floated 3% of their companies on the stock exchange. What is the free float that companies will be required to list going forward?
Ganbaatar: The new listing rules of the MSE and the FRC will require companies to float at least 25% of their outstanding shares. This should increase turnover, tradability and liquidity of the market.
Springer: Several name brand international banks have shown interest in partnering with local Mongolian banks to be the first to make available global custodian accounts in Mongolia. Is there a first mover established yet?
Ganbaatar: We are still in a process in which the international banks are in the midst of performing due diligence, researching local markets and selecting local partner banks. From my understanding, some conversations have taken place and some memorandums of understanding have already been signed. It’s a process in which the global custodians together with the local banks have to negotiate the terms of a long-term partnership. Finalization of the terms will lead to much expanded cooperation, starting with capacity building in Mongolia, selection and integration of the systems, relevant tests, passing and qualifying under new regulations, linking with SWIFT post-trading, building settlement infrastructures at the banks levels, et cetera, all of which usually requires a significant amount of time invested. We believe that sometime in the second half of this year the first global custodian banks will start operating in partnership with local banks.
Springer: The MSE Top 20 Index was up 137% in 2010. Do you have any safeguards in place to keep the market from overheating if the new custodial arrangements create a bull run in a market that currently has a market cap of about $1 billion?
Ganbaatar: Yes, we have in place automatic risk mitigation systems, such as static and dynamic circuit breakers and price bands. Static circuit breakers limit the movement of stocks from the prior day; whereas dynamic circuit breakers limit the movement of stocks from the prior trade. We also have trading bands that limit the stock movements of companies to 15% up or down per day.
Springer: With custodian relationships perhaps not available until the second half of this year, when do you expect to see the new investing laws make an impact on the market?
Ganbaatar: The main objective of the Investment Law is to convey the key message to investors that Mongolia is open to investors. The passage of the new laws have been received positively by the investor community, which was evident in improved volumes on the MSE and a significant rise in the MSE Top 20 Index. This shows how the MSE is a reflection of the opinions of investors regarding their investments in Mongolia.
Springer: For both the CEO of the Mongolia Stock Exchange and yourself, it is your last day on January 15 after three years on the job. What do you look forward to for the exchange and yourself next?
Ganbaatar: It’s been an amazing journey of taking over the modernization of Mongolian capital markets, enhancing the post-trading settlement environment and infrastructures in line with global standards and laying out the foundation by taking an active part in the introduction of new legal frameworks. Moving forward, the time has come to pass the torch along to the incoming management and for me to make the transition to the next stage of challenging undertakings to further promote the growth and development of Mongolia.
